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Will political concerns impact ECB decision-making?

With the focus turning to the ECB, markets will be keen to see whether the language has shifted in a more hawkish manner. With political and trade issues rearing their head, there is reason to believe that this month will be one of stability.

CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.

This week sees European Central Bank (ECB) president, Mario Draghi, take to the stand once more, where he is widely expected to announce that rates will remain at 0%, some two years after cutting them in early 2016. While there is little chance that we will see any shift from Draghi and co. when it comes to actual monetary policy, there is a growing clamour for a shift in tone from the committee.

Perhaps the number one driver for the ECB has been the pathway of inflation, which has thankfully remained somewhat subdued for many years now. However, a resurgence in price pressure throughout parts of 2017 raised the expectations of a potential push for a hawkish reversal from the ECB. Add to that the eurozone growth boom, and we have a picture of an economic region that could begin to heat up given the continued ultra-easy monetary policy from the ECB.

With pressure rising for the ECB to begin shifting the bias towards the hawkish stance seen from their UK and US counterparts, markets will be looking towards this month’s meeting for a shift in tone towards something more hawkish. The release of minutes on 22 February pointed towards discussions over whether to drop the more dovish commentary, yet decided against it on this occasion. The minutes stated that ‘some members expressed a preference for dropping the easing bias regarding the [QE programme] from the governing council’s communication as a tangible reflection of reinforced confidence in a sustained adjustment in the path of inflation.’

However, there is reason to believe that while this could come in the approaching months, we will not see it quite yet. Firstly, this past week has seen President Donald Trump impose steel and aluminium tariffs upon imports, hitting the EU particularly heavily given their standing as the second highest exporter of steel to the US (behind Canada). With both the EU and Canada threatening to respond in kind with similar measures, we have since heard from Trump, who cited the willingness to raise taxes on EU made cars. The threat of a tit-for-tat trade war is a huge risk for the eurozone recovery, given the size of their exports.

Secondly, we have just seen the Italian elections return a hung parliament, raising the political uncertainty within the zone. A hung parliament is not a disaster per se, yet the possibility of a coalition between the anti-establishment Five Star Movement and the far-right Northern League would certainly be a major source of uncertainty for the eurozone.

Lastly, the price pressures evident over the past year appear to be on the wane, with headline consumer price index (CPI) falling to a 14-month low of 1.2% in February. While this has been accompanied by a recent rise of core CPI (now 1%), there is still a comfortable bit of breathing space until the pressure returns, given the inflation target of 2%. One warning behind this theorem is that the ECB likes to utilise the 5y5y inflation swap measure as a gauge of inflation expectations. That currently lies around 1.7%, which highlights the fact that markets do expect to see inflation pick up over the coming years.

In summary, while the ECB is likely to shift its tone in one of the upcoming meetings, the pressure has seemingly eased, according to current inflation rates. Meanwhile, with political and trade clouds hanging overhead, it is likely that the typically risk averse ECB will hold off for the time being.

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CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.